Currency manipulation: Theory v. reality

Germany, China and other curious case studies

by Mark Sobel in Washington

Wed 22 Aug 2018

Willie Sutton, the famous US bank robber, when asked why he robbed banks allegedly said, 'Because that's where the money is.' He was a master in sleuthing how banks operated before he robbed them. The same spirit of forensic analysis is needed in assessing whether countries – as often stated by US politicians, including President Donald Trump – are 'manipulating' their currencies. Trump repeated the charge by telling Reuters on 20 August, 'I think China's manipulating their currency, absolutely. And I think the euro is being manipulated also.'

The International Monetary Fund recently estimated that global imbalances are 3.25% of world GDP, and 40%-50% of these are 'excessive'. In the spirit of Sutton, let's go where the money is.

Leading the list of key current account balances in 2017 was the euro area, with a surplus of $442bn (3.5% of GDP), two-thirds of which was accounted for by Germany ($ 297bn, around 8% of GDP). Japan and China had surpluses of $195bn and $167bn respectively (4.0% and 1.2% of GDP), while the US ran a deficit of $615bn (2.4% of GDP).

China is perhaps the most interesting alleged 'manipulation' case. The IMF projects that China's 2018 current account surplus will be under 1% of GDP. Even if China's trade balance is around 3.3% of GDP, that is far less than half of Germany's trade surplus. Reserves, while extremely high, are generally unchanged over the last year and intervention appears to have been scant. The Fund sees the real value of the renminbi as broadly consistent with underlying fundamentals.

China is where the screams about 'manipulation' are the loudest. But the case is by far the weakest.

In recent months, a new line of argumentation has emerged. Analysts argue China is letting the renminbi fall to compensate for current account losses, arising from Trump's higher tariffs; and/or that Chinese authorities are snubbing Trump to send Washington a message.

These arguments are not persuasive. The dollar has risen across the board. The renminbi's decline against the dollar since mid-April is broadly in line with the dollar's general rise. The reasons are clear – US growth is solid and interest rates are rising; China's growth appears to be moderating; and the Chinese authorities have been easing monetary policy. Washington's continued harsh rhetoric about tariffs against China further exacerbates renminbi selling. It is argued capital controls allow China to tightly manage the currency, but the capital controls are not hermetic.

The authorities' response to renminbi depreciation suggests they are trying to limit it. Reports indicate the central bank has been calling banks to warn against herd behaviour that could increase renminbi volatility. The authorities imposed a 20% reserve requirement on forward renminbi positions, raising the cost of short positions. They have called for the currency to remain broadly stable.

If one turns to other countries on the 'manipulation' radar, the euro area's large surplus reflects the huge surpluses of Germany and several northern European countries, and the demand compression that previously large deficit countries experienced in past years. It is hard to apply the concept of currency manipulation here. The European Central Bank hasn't intervened on the foreign exchange market; its monetary policy is appropriately accommodative, aimed at achieving its inflation objective.

Euro area member states neither conduct monetary policy nor have exchange rate policies. But they do control the other policies that are relevant to the question of 'excessive' surpluses. Which brings us to Germany, which has by far the world's largest individual current account surplus in nominal terms. At 8% of GDP, the relative level is also very high. Further, it almost all consists of the trade surplus. The IMF puts Germany's 'excessive' current account surplus at a whopping 5.5% of GDP, and the 'German euro's' undervaluation at 10%-20%.

The ECB's stance is too accommodative from a German perspective, but monetary policy must be formulated for the monetary union as a whole. Germany cannot 'manipulate' its exchange rate, as it doesn't have one. But imbalanced economic policies can yield the same result.

Germany's national saving is high, underpinned by strong household and robust corporate saving, plus fiscal surpluses bolstering public saving. To reduce its excessive surplus, Germany could increase fiscal spending for infrastructure and so on. But it is instead committed to the 'schwarze Null' ('black zero') or balanced budget. The authorities could also take a good look at policies underpinning why private household and corporate saving is so strong.

Japan is in a less problematic position. It has a current account surplus of 4%. But, according to the IMF, the current account norm is above 3%, implying a small 'excess'. The Fund sees the yen's value as broadly consistent with underlying Japanese fundamentals.

Were Sutton alive, espying such large sums stuffed in a bank, he would surely salivate. But before he struck, he'd apply keen analysis to casing the joint. My advice on the currency issue to Trump is that he needs to take similar precautions.

Mark Sobel is US Chairman of OMFIF. He is a former Deputy Assistant Secretary for International Monetary and Financial Policy at the US Treasury and until earlier this year US representative at the International Monetary Fund.

This is the second of two articles addressing US President Donald Trump's accusations of currency manipulation by China and Europe. The first article in the series can be read here.